At first glance, litigation funding and loans might appear similar—they both involve receiving money from an outside party to meet expenses. However, under Indian law and commercial practice, they are fundamentally different in structure, purpose, and legal treatment. Understanding these distinctions is critical for businesses and individuals considering how to finance a legal claim.
Litigation funding, or third-party funding (TPF), is an arrangement in which a non-party to the dispute finances some or all of the legal costs in exchange for an agreed share of the proceeds if the case is successful. It is non-recourse in nature, meaning the funder is repaid only if there is a recovery; if the case is lost, the claimant owes nothing. This structure shifts the financial risk of the litigation from the claimant to the funder. Under Indian jurisprudence, TPF is permissible for non-lawyers as long as the agreement is not extortionate or contrary to public policy, and advocates themselves do not fund their clients or work on contingency fees, as prohibited by the Bar Council of India (BCI) Rules. Several states have even amended Order XXV of the Code of Civil Procedure to formally acknowledge the existence of funders, empowering courts to order them to furnish security for costs.
In contrast, a loan—whether from a bank, NBFC, or private lender—is typically a recourse arrangement, meaning the borrower is obligated to repay the principal and interest regardless of the outcome of the case. Even if the litigation is unsuccessful, the borrower remains legally bound to repay. Loans are governed by money-lending laws, require repayment schedules, and accrue interest, sometimes with compounding. Because loans are regulated financial instruments, lenders may need a money-lending licence in the relevant state. For a borrower, this means the repayment obligation is absolute, and the lender’s risk is mitigated through interest and collateral rather than success in the dispute.
One of the most significant legal differences lies in regulatory classification. Litigation funding is not treated as a loan under Indian law when it is structured as truly non-recourse; the funder’s return is contingent solely on recovery from the claim. However, if an arrangement labelled as “litigation funding” includes an obligation to repay regardless of the outcome, or charges fixed interest on the amount advanced, it risks being reclassified as a loan. This reclassification could trigger compliance obligations under state money-lending statutes and even questions about enforceability if the lender lacks the necessary licence.
Another difference is the allocation of risk and control. In litigation funding, the funder bears the financial risk and, in return, may have certain consent rights on major strategic decisions such as settlement, while the claimant retains overall control of the case. In a loan arrangement, the lender typically has no say in litigation strategy; their interest lies purely in timely repayment. From the claimant’s perspective, funding offers the advantage of no downside liability if the case fails, but it usually comes at a higher effective cost than a standard loan because the funder’s return compensates for the risk of total loss.
Tax treatment is also different. Loan repayments are not income—they are a return of capital plus interest—but interest is taxable to the lender. In litigation funding, the claimant’s gross recovery is taxable per applicable laws, and the portion paid to the funder is part of the claimant’s expenditure; the funder’s return is income to them. The precise tax impact depends on the parties’ status, structure of the arrangement, and nature of the claim, making professional tax advice essential.
For businesses, the choice between litigation funding and a loan depends on priorities. If preserving cash flow and eliminating downside risk are critical, non-recourse funding is often preferable, even at a higher cost. If the business is confident in the outcome and can service debt, a loan may be cheaper overall, but it carries repayment obligations that persist regardless of success. For individuals with limited means, litigation funding can provide access to justice without the burden of debt, though the share of recovery given up can be substantial.
In short, while both litigation funding and loans provide capital, their legal frameworks, risk allocation, repayment obligations, and regulatory implications are very different. Misunderstanding these distinctions can lead to unintended compliance issues or financial exposure. For anyone considering either route in India, it is crucial to structure the arrangement correctly, ensure it aligns with BCI ethical rules, and document the terms in a clear, enforceable agreement.
Author: Advocate Dimple Rajpurohit (Bombay High Court)
Contact (Admin): info@nolegalpaisa.com
Last updated: 25-09-2025
